Economics and Business

Quarterly Reviews

Ahmed, Md. Tuhin, and Naher, Nurun. (2021), Modelling & Forecasting Volatility
of Daily Stock Returns Using GARCH Models: Evidence from Dhaka Stock
Exchange. In: Economics and Business Quarterly Reviews, Vol.4, No.3, 74-89.

ISSN 2775-9237

DOI: 10.31014/aior.1992.04.03.371

The online version of this article can be found at:

https://www.asianinstituteofresearch.org/

Published by:
The Asian Institute of Research

The Journal of Economics and Business is an Open Access publication. It may be read, copied, and distributed
free of charge according to the conditions of the Creative Commons Attribution 4.0 International license.

The Asian Institute of Research Journal of Economics and Business is a peer-reviewed International Journal. The
journal covers scholarly articles in the fields of Economics and Business, which includes, but not limited to,
Business Economics (Micro and Macro), Finance, Management, Marketing, Business Law, Entrepreneurship,
Behavioral and Health Economics, Government Taxation and Regulations, Financial Markets, International
Economics, Investment, and Economic Development. As the journal is Open Access, it ensures high visibility and
the increase of citations for all research articles published. The Journal of Economics and Business aims to
facilitate scholarly work on recent theoretical and practical aspects of Economics and Business.

Electronic copy available at: https://ssrn.com/abstract=3893019

 The Asian Institute of Research
Economics and Business Quarterly Reviews
Vol.4, No.3, 2021: 74-89
ISSN 2775-9237
Copyright © The Author(s). All Rights Reserved
DOI: 10.31014/aior.1992.04.03.371

Modelling & Forecasting Volatility of Daily Stock Returns

Using GARCH Models: Evidence from Dhaka Stock
Exchange
Md. Tuhin Ahmed1, Nurun Naher2
1
Senior Research Associate, South Asian Network on Economic Modeling (SANEM), Dhaka, Bangladesh.
Email: [email protected]
2
Graduate Research Assistant, College of Liberal Arts, Auburn University, Alabama, United States.
Email: [email protected]

Abstract
Modelling volatility has become increasingly important in recent times for its diverse implications. The main
purpose of this paper is to examine the performance of volatility modelling using different models and their
forecasting accuracy for the returns of Dhaka Stock Exchange (DSE) under different error distribution
assumptions. Using the daily closing price of DSE from the period 27 January 2013 to 06 November 2017, this
analysis has been done using Generalized Autoregressive Conditional Heteroscedastic (GARCH), Asymmetric
Power Autoregressive Conditional Heteroscedastic (APARCH), Exponential Generalized Autoregressive
Conditional Heteroscedastic (EGARCH), Threshold Generalized Autoregressive Conditional Heteroscedastic
(TGARCH) and Integrated Generalized Autoregressive Conditional Heteroscedastic (IGARCH) models under
both normal and student’s t error distribution. The study finds that ARMA (1,1)- TGARCH (1,1) is the most
appropriate model for in-sample estimation accuracy under student’s t error distribution. The asymmetric effect
captured by the parameter of ARMA (1,1) with TGARCH (1,1), APARCH (1,1) and EGARCH (1,1) models
shows that negative shocks or bad news create more volatility than positive shocks or good news. The study also
provides evidence that student’s t distribution for errors improves forecasting accuracy. With such an error
distribution assumption, ARMA (1,1)-IGARCH (1,1) is considered the best for out-of-sample volatility
forecasting.

Keywords: ARCH, GARCH, Volatility, Forecasting, DSE

1. Introduction

Over the past decades, modelling and forecasting volatility of financial time series has become a fertile area for
research (Zakaria & Winker, 2012). Many models in the field of academic finance use variance (or standard
deviation) as a measure of uncertainty (Niyitegeka & Tewari, 2013). “In most of these models’ variance is assumed
to be constant through time; this is known as homoscedasticity” (Brooks, 2002, p. 386). Financial time series such
as stock prices often exhibit volatility clustering. The time series are found to depend on their own past values and

74

Electronic copy available at: https://ssrn.com/abstract=3893019

Asian Institute of Research Economics and Business Quarterly Reviews Vol.4, No.3, 2021

exhibit non-constant variance or heteroscedasticity. A time series with some periods of low volatility and some
periods of high volatility is said to be “volatility clustering” (Banumathy & Azhagaiah, 2013). It has been found
that the stock market volatility changes with time and exhibits “volatility clustering.”

The knowledge of volatility is of crucial importance for many economic and financial applications like portfolio
management, risk management, asset pricing and investment in general (Floros, 2008; Niyitegeka & Tewari, 2013,
Zakaria & Winker, 2012; Parvaresh & Bavaghar, 2012). Volatility is the most important variable in evaluating
derivative instruments. Volatility is closely related to risk. Investors in the stock market are obviously interested
in analysing and learning about the nature of the stock market volatility of stock prices, for high volatility could
mean huge losses or gains and hence greater uncertainty (Parvaresh & Bavaghar, 2012).

Several models have been developed since the 1980s that are especially suited to estimate the conditional volatility
of financial assets (Zakaria & Winker, 2012). Frequently applied models of this type are the generalized
conditional heteroscedastic models (Zakaria & Winker, 2012). Engle (1982) introduced Autoregressive
Conditional Heteroscedasticity (ARCH) to the world to model financial time series that exhibit time-varying
conditional variance. A generalized ARCH model (GARCH) was extended by Bollerslev (1986). These are
popular models for estimating stochastic volatility. These models are widely used in time series econometrics,
especially in financial time series analysis. With the introduction of models of ARCH and GARCH, there have
been wide empirical applications of modelling volatility of financial time series. However, the GARCH cannot
account for leverage and to account for that effect, APARCH, E-GARCH and T-GARCH models have been
developed over time.

However, it is widely recognized among researchers that for excess kurtosis along with an increase in data
frequency, the rate of return in financial variables might have a levy distribution or a fat-tailed (Mandelbrot, 1963).
Under normality assumption for errors, the volatility modelling and forecasting based on such modes will be
misleading. The main objective of this paper is to model stock returns volatility in Dhaka Stock Exchange (DSE)
by employing different GARCH family type models for daily observations on the index returns series over the
period of 27 January 2013 to 06 November 2017. The volatility models employed in this paper include both
symmetric and asymmetric GARCH models. Moreover, student’s t distribution is used to correctly model and
forecast the volatility of stock return and normal distribution for errors is used to compare with student’s t
distribution for errors. The rest of the paper organized as follows: Section 2 provides the relevant literature review.
Section 3 describes data and potential methodology. Section 4 provides estimation results and their discussion
respectively. Section 5 provides the results of volatility forecasting both in-sample estimation and out-of-sample
forecasting accuracy. Finally, the paper concludes and suggests some policy implications.

2. Literature Review

GARCH family models have been used in scholarships by authors from different corners of the world for the
modelling and forecasting of daily stock returns (Floros, 2008; Niyitegeka & Tewari, 2013; Peters, 2001;
Karmakar, 2005; Banumathy & Azhagaiah, 2013; Zakaria & Winker, 2002; Abd El Aal, 2011; Parvaresh
& Bavaghar, 2012; Qamruzzaman, 2015; Huq, Rahman, Rahman, Shahin, & Ali, 2013). The most used models
are GARCH(1,1), GARCH-M(1,1), exponential GARCH(1,1), threshold GARCH(1,1) and power GARCH(1,1).
The first two models imply the symmetric effect of past shocks whereas the second group of models allows
capturing asymmetric effects. Stock market volatility is widely studied both in developed markets like Israel
(Floros 2008), South Africa (Niyitegeka & Tewari, 2013), Europe (Peters, 2001) and emerging markets like India
(Karmakar, 2005; Banumathy and Azhagaiah, 2013), Egypt (Zakaria & Winker, 2002; Floros, 2008; Abd El Aal
2011), Iran (Parvaresh & Bavaghar, 2012), Sudan (Zakaria & Winker, 2002). However, studies in the context of
Bangladesh are almost non-existent since two scholarships are found only regarding the analysis of Dhaka and
Chittagong stock market (Qamruzzaman, 2015; Huq et al., 2013).

In the middle eastern stock markets, EGARCH models are seen to be dominant in determining the leverage effect
of daily stock prices (Floros, 2008; Parvaresh & Bavaghar, 2012). Floros (2008) examined the volatility in

75

Electronic copy available at: https://ssrn.com/abstract=3893019

Asian Institute of Research Economics and Business Quarterly Reviews Vol.4, No.3, 2021

Egyptian and Israeli stock indices and found coefficients of the EGARCH model showed a negative and significant
value for both indices, indicating the existence of the leverage effect. Parvaresh and Bavaghar (2012) have
examined GARCH models in forecasting volatility for Tehran Stock Market and the study suggested that GARCH
models used in this paper have the same forecasting power while evaluating forecasting with MSE criteria, while
CGARCH has the best forecasting power given the log-likelihood is evaluation criteria. Abd El Aal (2011)
examined five models for forecasting volatility of the Egyptian stock market index and employed different
statistical metrics. After using usual statistical metrics, they found that the EGARCH model beat the other volatility
forecasting models for the Egyptian stock market. However, after using DM statistics they found no significant
differences between the forecasting volatility models performance.

However, the scholarships relating to African stock markets employed symmetric and asymmetric GARCH
models to model volatility that capture the most common stylized facts about index returns such as volatility
clustering and leverage effects (Zakaria & Winker, 2002; Niyitegeka & Tewari 2013; Abd El Aal 2011). Zakaria
and Winker (2002) examined the return volatility using daily prices of Khartoum Stock Exchange (KSE) and Cairo
and Alexandria Stock Exchange (CASE) where the results showed significant evidence for the existence of the
leverage effects in the two markets, based on asymmetrical EGARCH (1,1) and TGARCH (1,1) estimation.
However, the result of EGARCH and GJR-GARCH (1,1) failed to indicate the existence of leverage effects in
South African stock returns (Niyitegeka & Tewari, 2013). In terms of volatility in African stock markets, results
indicate the mixed outcome. GARCH-M (1,1) described statistically significant conditional variance for Egyptian
and Sudanese stock markets with a positive sign (Zakaria & Winker, 2002). On the other hand, the results from
the GARCH (1,1) model show that volatility of stock returns is persistent in South Africa (Niyitegeka & Tewari,
2013). However, some studies are limited as they did not test to what extent volatility forecasts based on the
present models are useful in the context of risk management for the stock markets considered (Zakaria & Winker
2002).

Meanwhile, the only western stock markets literature reviewed in this paper, studied two major European stock
exchanges using daily data over a 15-years period (Peters, 2001). Study results revealed that overall estimation is
improved when fat-tailed densities are considered in the conditional variance and when asymmetric GARCH is
used. In addition to that, GJR and APARCH models are found to be giving better forecasts than symmetric
GARCH.

South Asian stock markets studied the heteroscedasticity behaviour of the stock markets making use of several
GARCH models (Karmakar, 2005; Banumathy & Azhagaiah 2013; Qamruzzaman, 2015). Banumathy and
Azhagaiah (2013) showed that bad news or negative shocks create more volatility than positive shocks or good
news by giving negative and positive significant coefficients for EGARCH (1,1) and TGARCH (1,1) models
respectively. Karmaker (2005) showed the suitability of the GARCH (1,1) model that gave remarkably good
forecasts of market volatility. The scholarships again produced mixed results in the South Asian stock market in
terms of capturing symmetric and asymmetric volatility. Some studies examined whether there is asymmetric
volatility by using the E-GARCH models and observed that volatility is an asymmetric function of past innovation
that increases at a higher rate during market decline (Karmakar, 2005). However, GARCH (1,1) and TGARCH
(1,1) estimators are found to be the most suitable models to capture the symmetric and asymmetric volatility
respectively in some other studies (Banumathy & Azhagaiah, 2013). Qamruzzaman (2015) examined a wide
variety of popular volatility models for Chittagong Stock Exchange (CSE) and the results indicated that GARCH-
z, EGARCH-z, IGARCH-z, GJR-GARCH-z and EGARCH-t are suitable for that specific stock exchange with the
volatility of the return being significantly higher after 2009. An important limitation of some studies being their
suffering from the constraint of non-calculation of intraday volatility and only used a short period of time-series
data (Banumathy & Azhagaiah, 2013).

In a different study, Abdullah, Siddiqua, Siddiquee, and Hossain (2017) tried to model and forecast exchange rate
volatility by addressing the issue of error distributional assumption between the Bangladeshi taka and the US
dollar. This study attempted to model the dynamics by using five different models from January 1, 2008, to April
30, 2015, under both normal and student’s t distribution. The models’ findings were compared under the regular
normal distribution assumption for the residuals against Student’s t-distribution and it was later found that the

76

Electronic copy available at: https://ssrn.com/abstract=3893019

Asian Institute of Research Economics and Business Quarterly Reviews Vol.4, No.3, 2021

application of student’s t distribution improved forecasting accuracy more than the normal distribution. Moreover,
the findings also indicated that for modelling in-sample volatility dynamics, AR (2)–IGARCH (1, 1) was found to
be the most accurate, while AR (2)-GARCH (1,1) gave the best performance under error distribution for the out-
of-sample volatility forecasting.

However, there are relatively fewer studies on the stock return volatility of DSE. In one current example, Huq et
al. (2013) modelled the stock return volatility using daily closing price data from December 06, 2010, to March
12, 2013. According to them, ARMA (1,1) with GARCH (1,1) and GARCH (2,1) are more appropriate models
for the general index of the Dhaka Stock Exchange (DSE). But this study has some limitations. They addressed
the lag specification of the mean equation properly, but they did not consider the excess kurtosis and skewness.
Hence, their results may be misleading. Besides, the I-GARCH model was not used even though the sum of the
persistence parameter exceeds the unitary value of almost all the papers. We were appreciative of the work of
Abdullah et al. (2017) on exchange rate volatility and therefore attempted to apply the I-GARCH model in the
field of stock return volatility of DSE. However, there is a need to identify the true nature of stock market volatility
in an emerging market like Bangladesh. Moreover, selecting proper mean equations, addressing excess kurtosis
by using student’s t distribution and selecting appropriate models may contribute to the field of stock return
volatility of DSE. This paper, therefore, analyses the presence and pattern of the volatility clustering in the Dhaka
stock index return series using the GARCH family of models. Additionally, the study examines the presence of
leverage effect or asymmetric information effect in the DSE index and thus contributes to the existing literature.

3. Data and Methodology

3.1 Data Sources and Variable Formation

The study is based on the secondary data that was collected from Dhaka Stock Exchange Indices. The daily closing
price of the DSE general index namely DSEX over five years from 27 January 2013 to 06 November 2017 were
considered for the analysis. The study used 1153 daily observations excluding holidays. Since the daily closing
price is normally nonstationary, it is inappropriate for the analysis. However, several studies (Karmakar 2005,
Abdullah et al., 2017) suggest estimating the volatility of the return series. The DSE daily stock return series is,
therefore, calculated using the following log transformation:

#$
r" =ln( # )
$%&

Or r" =ln (p" )-ln (p"() )

Where 𝑟+ is the logarithmic return on DSE indices for time t, 𝑝+ is the closing price at time t, and 𝑝+() is the
corresponding price in the period at time t-1. The statistical software EViews 7 was used for the quantitative
analysis.

3.2 Methodology

3.2.1 Unit Root Test

In a time series, the stationary check is a must. Unit root test is usually used to test whether the data are stationarity.
In this regard, the study performed Augmented Dickey-Fuller Test (ADF) and Kwiatkowski-Phillips-Schmidt-
Shin (KPSS) Test.

3.2.2 The ARCH Model

It is well known that volatility is commonly modelled by GARCH family models. Usually, one can use the mean
equation for the level of the series and then the ARCH model is used for modelling the variance. When data are
serially correlated, the misspecification of the mean equation could fail to address the autocorrelation problem that

77

Electronic copy available at: https://ssrn.com/abstract=3893019

Asian Institute of Research Economics and Business Quarterly Reviews Vol.4, No.3, 2021

could arise in the volatility model. Hence, the accurate specification of the mean equation is very important. We,
therefore, estimated all the GARCH family models for the following appropriate mean equation:

Mean Equation: ARMA (1,1)

r" = µ + ƿ) r"() + p. ε"() + ε"

We used five different GARCH family models to specify the variance equation to model volatility for different
purposes. The sensitivity of the estimation results of the models was checked by changing distributional
assumptions. The distributional assumption is changed from normal to student’s t distribution. The reason is that
in many pieces of literature on financial asset returns, it is established that the return variable is more likely to
follow a “levy distribution” with “fat tails” and kurtosis is likely to increase with data frequency (Andersen &
Bollerslev, 1998). The useful variance equation is assumed as:

Variance equation:

𝜀+ = 𝑣+ 2ℎ+

Where, v" ~ i.i.d (0,1) and

ℎ+ = 𝑣+ 2𝛼7 + 𝛼𝜀+() .

3.2.3 The Generalized ARCH (GARCH) Model

The Pioneer of modelling volatility, Engle (1982) used Autoregressive Conditional Heteroscedasticity (ARCH)
model to model volatility. But the main problem with the ARCH model is that in practice, a long lag is often
required to capture the time-varying volatility. The GARCH model proposed by Bollerslev (1986) allows
conditional variance to depend upon its lag which typically reduces the number of ARCH lags required. So, the
conditional variance equation should follow as:

GARCH (1,1): ℎ+ = 𝛼9 + 𝛼𝜀+() . + βℎ+()

Here, the GARCH (1,1) model has one ARCH term denoted as 𝜀+() . and one GARCH term denoted as ℎ+() . For
the variance to remain well behaved (finite and positive), some restrictions are needed: α ≥ 0, 𝛼9 >0,𝛽 ≥ 0. The
sum of the ARCH and GARCH coefficients leads to the persistency of volatility shocks. To ensure that series ε" is
stationary and the variance is well behaved, it is necessary to assume that α +β˂1.

3.2.4 The Symmetric Power ARCH or (APARCH) model

Ding, Granger, and Engle (1993) introduced the asymmetric power ARCH or (APARCH) model. The APARCH
(1,1) can be expressed as:

APARCH (1,1): ℎ+ ɗ = 𝛼9 + α (|𝜀+() | − γ𝜀+() )ɗ + βℎ+() ɗ

This model is developed to allow for possible non-linearity in the parameters of the variance equation. Here ɗ
donates the power parameter that requires that ɗ>0 and γ is the parameter capturing any asymmetric or leverage
effect which requires the condition |γ|<1.

3.2.5 The Exponential GARCH (EGARCH) model

78

Electronic copy available at: https://ssrn.com/abstract=3893019

Asian Institute of Research Economics and Business Quarterly Reviews Vol.4, No.3, 2021

The main drawback of the standard GARCH (1,1) model is that the conditional variance is unable to respond
asymmetrically to the rise and fall in the stock returns. This model suggests that the shock in 𝜀+() has the same
effect irrespectively of whether 𝜀+() > 0 or 𝜀+() < 0. A typical feature of financial data is that negative shocks
or bad news create more volatility than positive shocks or good news. To test the presence of leverage effect in
financial data, Nelson (1991) proposed the Exponential Autoregressive Conditional Heteroscedasticity
(EGARCH) model. The EGARCH model is given by:

GH%& G
EGARCH (1,1): ln (ℎ+ )= 𝛼7 + αF
2IH%&
F + γF2IH%& F +β lnℎ+()
H%&

Where α is the size parameter measuring the magnitude of shocks, γ is the asymmetric parameter measuring
leverage effect, β measures the persistence in conditional volatility irrespectively of shocks to the market. An
important feature of the EGARCH model is that there is no need for any non-negativity restrictions.

3.2.6 The Threshold GARCH (TGARCH) model

The threshold Generalized Autoregressive Conditional Heteroscedasticity (TGARCH) model was introduced by
Zakoian (1994) and Glosten, Jagannathan, and Runkle (1993). The threshold GARCH (1,1) model specification
follows as

(1; 𝑖𝑓𝜀𝑡 − 1 < 0

TGARCH (1,1): ℎ+ = 𝛼9 + 𝛼𝜀+() . +γ𝑑+() 𝜀+() . + βℎ+() 𝑑+() = L R
0; 𝑖𝑓𝜀𝑡 − 1 ≥ 0

Where, ε"() > 0 (good news) and ε"() < 0 (bad news) produces a differential effect on conditional variance.
Good news has an impact on α while bad news has the impact of (α+γ). When γ is significant and positive, negative
shocks have a larger effect on volatility than positive shocks. Here non-negativity restrictions also need for α, α9 ,γ
and β like that of standard GARCH (1,1).

3.2.7 The Integrated GARCH (IGARCH) Model

GARCH model with unit root (non-stationary GARCH model) can be regarded as an integrated GARCH or
IGARCH model. This model was originally developed by Engel (1982) and Bollerslev (1986). In practice, when
the parameters of the GARCH model are restricted to a sum equal to one and ignore the constant term, a standard
GARCH model is transformed into an IGARCH model.

IGARCH (1,1): ℎ+ = 𝛼𝜀+() . +(1-𝛂)ℎ+()

Where the additional constraints are {α+(1-α)} = 1 and 0<α<1

4. Results and Discussion

The daily closing price of the DSE index is non-stationary. This non-stationary behaviour can be seen from the
graph of the daily price which is presented in Figure 1 (Appendix). To make the series stationary, the daily closing
price of the DSE index is converted into daily logarithmic return series. This return series is now stationary, which
is shown in Figure 2. (Appendix). Descriptive statistics on DSE stock return are summarized in Table 1.

Table 1: Descriptive statistics of the DSE return series

Statistics Values
Mean 0.000355
Median 0.000215
Maximum 0.036847
Minimum -0.053585

79

Electronic copy available at: https://ssrn.com/abstract=3893019

Asian Institute of Research Economics and Business Quarterly Reviews Vol.4, No.3, 2021

Standard Deviation 0.008394

Skewness -0.161429
Kurtosis 6.588151
Jarque – Bera 623.5359
Probability 0.00000
Observations 1153

The mean of the returns is positive, indicating that the price has increased over the period. Statistically, the risk or
volatility is the dispersion of the returns. Daily performance (average probability) for the period is 0.000355 and
the risk (standard deviation) per day is 0.008394 which reflects the high volatility of the Dhaka Stock Index. The
descriptive statistics show that the returns are negatively skewed, indicating that there is a high probability of
earning returns that is greater than the mean. The kurtosis of the series is greater than 3 which implies that the
return series is fat-tailed and does not follow a normal distribution. The histogram of the return series shown in
Figure 3 (Appendix) remains centred at the zero with a slight negative bias (-0.161429) and a kurtosis value of
(6.588151) which shows excess kurtosis regarding the standard normal and is further confirmed by the Jarque-
Bera test statistics which is significant of 1% level and hence the null hypothesis of normality is rejected.

To detect if the DSE return series is stationary, a unit root test is carried out with the statistical Augmented Dickey-
Fuller (ADF) and Kwiatkowski-Phillips-Schmidt-Shin (KPSS) test.

Table 2: Stationarity test for the DSE return series

Augmented Dickey-Fuller (ADF) test
Ho: Return Series has a unit root
Intercept Trend & Intercept
Test Statistic -30.50930 -30.51298
Probability 0.0000 0.0000

Kwiatkowsk-Phillips-Schmidt-Shin (KPSS) test

Ho: Return Series is stationary
Intercept Trend & Intercept
Test statistic 0.078875 0.047207
1% critical values 0.739000 0.216000

Table 2 shows the presence of unit root in the series tested using ADF and KPSS tests. The p -values of ADF with
both “intercept” & “trend and intercept” are less than 0.01 which leads to conclude that the data of the time series
for the entire period is stationary. The p-value of the KPSS test with both “intercept” & “trend and intercept” is
greater than 0.01 which leads us to conclude that the null hypothesis of “return series is stationary” is accepted at
a 1% level. Both the ADF and KPSS test reported in Table 2 confirms that the return series is stationary.

Table 3: Estimation of conditional mean model and testing for ARCH effect
Variables Coefficients
(Dependent Variable,𝒓𝒕 )
µ 0.000323
(0.000339)
𝒓𝒕(𝟏 0.772003***
(0.097197)
𝜺𝒕(𝟏 -0.685053***
(0.111587)
ARCH Effect (Dependent variable,𝜺𝒕 )
Constant 4.55E-05***
(5.00E-06)

80

Electronic copy available at: https://ssrn.com/abstract=3893019

Asian Institute of Research Economics and Business Quarterly Reviews Vol.4, No.3, 2021

𝜺𝒕(𝟏 0.339794***
(0.339794)
Ho: No ARCH Effect
F statistic 149.9683***
Probability 0.0000
Standard Errors are in parenthesis. ***,**,* indicates significant at 1%, 5% and 10% level respectively.

The estimation result of the conditional mean model for the logarithmic stock return using the Ordinary Least
Squares (OLS) method is presented in Table 3. Since the series was observed to be mean reverting, OLS was
applied to estimate the regression. The model was not augmented with further AR and MA terms because they
were not significant.

The Heteroscedasticity test is applied to find out the presence of ARCH effect in the residuals of the return series.
From Table 3, it is concluded that the F-statistics is highly significant. Since the p-value is less than 0.01, the null
hypothesis of “no ARCH effect” is rejected at a 1% level which confirms the presence of ARCH effects in the
residuals of time series models in the returns.

The volatility clustering of return series for the study period from 27 January 2013 to 06 November 2017 is also
been observed (Figure 4 (Appendix)). It shows that the period of low volatility tends to be followed by a period of
low volatility for a prolonged period and the period of high volatility is followed by a period of high volatility for
a prolonged period, which means the volatility is clustering and the return series vary around the constant mean,
but the variance is changing with time. Hence, these results suggest the estimation of GARCH family models.

Since the ARCH effect is detected in the model, GARCH family model is therefore used for modelling the
volatility of return series in the Dhaka Stock Exchange Market.

Table 4: Estimation results of GARCH (1,1) model with normal and student-t distribution
Coefficients GARCH (1,1) with normal GARCH (1,1) with student’s t
distribution distribution
µ 0.000562** 0.000525**
(0.000221) (0.000230)
ƿ𝟏 0.624279*** 0.641317***
(0.109187) (0.104261)
ƿ𝟐 -0.488288*** -0.500652***
(0.130069) (0.123571)
𝜶𝟎 7.04E-07** 7.24E-07***
(3.09E-07) (3.30E-07)
α 0.153107*** 0.152057***
(0.020740) (0.022947)
β 0.844343*** 0.844678***
(0.019438) (0.021246
α+β 0.99745 0.996736
Log-likelihood 4101.584 4102.530
ARCH-LM test for heteroscedasticity
ARCH-LM test statistics 0.0540 0.0586
Prob, chi-square (1) 0.0540 0.0585
Standard Errors are in parenthesis. ***,**,* indicates significant at 1%, 5% and 10% level respectively.

The GARCH (1,1), model is applied for the purpose of capturing variance dynamics. Table 4 shows the estimation
results. Here, it is evident that the autoregressive coefficients of this lagged dependent variable for the mean
equation ƿ) and MA (1) coefficient ƿ. for the mean equation are statistically significant at 1% level.

81

Electronic copy available at: https://ssrn.com/abstract=3893019

Asian Institute of Research Economics and Business Quarterly Reviews Vol.4, No.3, 2021

The coefficients of the GARCH components (α and β) are positive and statistically significant at a 1% level (Table
4). In the conditional variance equation, the estimated β coefficient shows that the volatility is persistent. The sum
of these parameters (α and β) is 0.99745, which is close to unity indicating that the stock will persist to many future
periods. Further, ARCH-LM test is employed to check ARCH effect in residuals and from the result, it is inferred
that the p>0.05, which led to conclude that the null hypothesis of “no ARCH effect” is accepted. In other words,
the test statistics do not support any additional ARCH effect remaining in the residuals of the models, which
implies that the variance equation is well specified for the market.

Table 5: Estimation results of the APARCH (1,1) model with normal and student t distribution
Coefficients APARCH (1,1) with normal APARCH (1,1) with student’s t
distribution distribution
µ 0.000311 0.000299
(0.000238) (0.000242)
ƿ𝟏 0.688410*** 0.692550***
(0.093600) (0.091479)
ƿ𝟐 -0.553730*** -0.555000***
(0.113572) (0.111034)
𝜶𝟎 2.71E-06 2.96E-06
(5.94E-06) (6.79E-06)
α 0.147482*** 0.148116***
(0.020624) (0.021964)
𝛄 0.179302*** 0.178892***
(063007) (0.066680)
ɗ 1.743423*** 1.732061***
(0.425484) (0.445515)
β 0.855087*** 0.854436***
(0.425484) (0.022750)
α+β 1.002569 1.002552
Log-likelihood 4107.561 4107.990
ARCH-LM test for Heteroscedasticity
ARCH-LM test statistics 0.0430 0.0425
Prob.chi-square (1) 0.0430 0.0425
Standard Errors are in parenthesis. ***,**,* indicates significant at 1%, 5% and 10% level respectively.

The results from the APARCH model is presented in Table 5, and it is evident that the autoregressive coefficient
of the lagged dependent variable 𝜌) for the mean equation and MA (1) coefficient 𝜌. are statistically significant
at the 1% level. The coefficients α and β are again found to be positive and statistically significant at 1% level,
having a sum greater than 1 for both distributions. The coefficient ɗ is positive and significant and not equal to 2
which implies that it is not a standard GARCH model (Ding et al., 1993). The significance and sign of the
coefficient γ determine the leverage effect.

The positive significant value of γ indicates the existence of a leverage effect where negative past values of
𝜀+ increase volatility more than positive past values of the same magnitude. Table 5 also shows, the leverage effect
is positive and significant. Thus, an asymmetric volatility effect exists for stock returns. The coefficients of the
ARCH & GARCH sum to more than 1 and the constant term in the variance equation of the APARCH model
using both normal and student t distribution are not statistically different from 0. Thus, as the necessary non-
negativity restrictions have not been satisfied, so the variance equation is not well behaved.

To capture the asymmetric effect in the return series and eliminate the problem of non-negativity restrictions, we
estimate an EGARCH model. Table 6 shows the estimation result of the EGARCH (1,1) model using both normal
and student t distribution.

82

Electronic copy available at: https://ssrn.com/abstract=3893019

Asian Institute of Research Economics and Business Quarterly Reviews Vol.4, No.3, 2021

Table 6: Estimation results of EGARCH model with normal and student’s t distribution
EGARCH with EGARCH with student’s
Coefficients
Normal distribution T distribution
0.000232 0.000225
µ
(0.000229) (0.000233)
0.701056*** 0.696559***
ƿ𝟏
(0.91658) (0.091011)
-0.574259*** 0.564811***
ƿ𝟐
(0.111412) (0.110250)
-0.422221*** -0.432761***
𝜶𝟎
(0.079043) (0.086100)
0.274410*** 0.276309***
α
(0.031330) (0.034090)
-0.053319*** -0.053416***
𝛄
(0.017888) (0.019448)
0.979282*** 0.978365***
β
(0.006898) (0.007527)
α+β 1.253692 1.254674
Log-likelihood 4106.421 4107.027
ARCH-LM test for Heteroscedasticity
ARCH-LM test statistics 0.0766 0.0740
Prob. Chi-square (1) 0.0765 0.0739
Standard Errors are in parenthesis. ***,**,* indicates significant at 1%, 5% and 10% level respectively.

The sum of ARCH(α) & GARCH (β) is greater than one (Table 6), reporting that the conditional variance is
explosive. Here in the variance equation γ is popularly known as the “asymmetry parameter” and a represents the
“size parameter”. The estimated coefficients are statistically significant at a 1% level. The leverage coefficient, γ
is negative and statistically significant at 1% level, exhibiting the leverage effect in return during the study period.
The analysis reveals that there is a negative correlation between past return and future return. Hence, EGARCH
(1,1) model supports the presence of leverage effect on the DSE return series. Finally, the ARCH-LM test statistics
reveals that the null hypothesis of no heteroscedasticity in the residuals is accepted.

An alternative model to test for asymmetric volatility in the DSE return is TGARCH. Table 7 shows the estimation
results of TGARCH using both normal and student’s t distribution.

Table 7: Estimation results of TGARCH model with normal and student’s t distribution
Coefficients TGARCH with normal distribution TGARCH with student’s t
distribution
µ 0.000332 0.000321
(0.000237) (0.000241)
ƿ𝟏 0.680906*** 0.686704***
(0.093303) (0.091275)
ƿ𝟐 -0.544337*** -0.547455***
(0.113327) (0.110726)
𝜶𝟎 7.21E-07** 7.41E-o7**
(2.86E-07) (3.04E-07)
α 0.099293*** 0.099744***
(0.023211) (0.024485)
𝛄 0.1000258*** 0.100312***
(0.031708 (0.33991)
β 0.848170*** 0.847306***
(0.019109 (0.02081

83

Electronic copy available at: https://ssrn.com/abstract=3893019

Asian Institute of Research Economics and Business Quarterly Reviews Vol.4, No.3, 2021

α+β 0.947463 0.947048

Log-likelihood 4107.347 4107.768
ARCH-LM test for heteroscedasticity
ARCH-LM test statistics 0.1072 0.1065
Prob. chi-square (1) 0.1072 0.1065
Standard Errors are in parenthesis. ***,**,* indicates significant at 1%, 5% and 10% level respectively.

Table 7 shows that the coefficient of leverage effect is positive and significant at a 1% level, which implies that a
negative shock or bad news has greater volatility on the condition variance than the positive shocks or good news.
The diagnostic test is performed to test whether there is an ARCH effect. The ARCH-LM test statistics for TARCH
(1,1) model show that there are no additional ARCH effects in the residuals of the model.

Since it has been found that the sum of the persistence parameters exceeds 1 for some models, it can be deduced
that the variance might not be well behaved in such models. Therefore, it would be interesting to model volatility
clustering with such models while imposing restrictions on the persistence parameters. Our popular restriction on
the “persistent parameters sum up to unit”. Thus, the estimation of GARCH models with this restriction leads to
the IGARCH model. Table 8 shows the estimation result of IGARCH (1,1) using both normal and student t
distribution.

Table 8: Estimation results of IGARCH (1,1) model with normal and student’s t distribution
IGARCH with student’s t
Coefficients IGARCH with normal distribution
distribution
0.000540*** 0.000512***
µ
(0.000166) (0.000181)
0.634229*** 0.652534***
ƿ𝟏
(0.095513) (0.090678)
-0.502716*** -0.513506***
ƿ𝟐
(0.113702) (0.107578)
0.115773*** 0.114814***
α
(0.010529) (0.011925)
0.884227*** 0.885186***
1-α
(0.010529) (0.011925)
Log-likelihood 4092.622 4094.235
ARCH-LM test for heteroscedasticity
ARCH-LM test statistics 0.1362 0.1495
Prob. chi square (1) 0.1360 0.1492
Standard Errors are in parenthesis. ***,**,* indicates significant at 1%, 5% and 10% level respectively.

The IGARCH (1,1) model successfully overcomes all of the diagnostic tests for both normal and student’s t
distribution, is used as the error distribution (Table 8). There is no additional ARCH effect and no autocorrelation
detected in the regular and squared residuals. Finally, the evidence indicates that all of the models (GARCH,
EGARCH, TGARCH & IGARCH without APARCH) satisfy the required diagnostic standard under both normal
distributions as well as student’s t distribution as the assumption for the residuals.

5. Volatility Forecasting

5.1 In-sample estimation performance

To find out whether the accuracy of volatility forecasting among the five models (GARCH, APARCH, EGARCH,
TGARCH & IGARCH) varied with distributional assumptions, we compared the log-likelihood, Schwarz
Bayesian Information Criterion (BIC), and Akaike Information Criterion (AIC) for all those models, estimating
for the whole sample observations under normal and student’s t distribution. Table 9 shows the results. The

84

Electronic copy available at: https://ssrn.com/abstract=3893019

Asian Institute of Research Economics and Business Quarterly Reviews Vol.4, No.3, 2021

performance of each model improved under the student’s t distribution. The reason behind that log-likelihood
increased while both AIC and BIC decreased compared to the normal distributional assumptions applied for the
residuals. Considering the student’s t distribution for the residuals, a comparison of log-likelihood indicates that
among all the models used for in-sample estimation, ARMA (1,1)-APARCH (1,1) is the best since it has maximum
likelihood and a comparison of BIC and AIC indicators that among all the models used for in-sample estimation,
ARMA (1,1)-TGARCH (1,1) is the best since it has lowered BIC and AIC. However, the ARMA (1,1)-APARCH
(1,1) model is more problematic since it can’t overcome any of the diagnostic tests, that is, there exist additional
ARCH effects and autocorrelation problem in the residuals. Without APARCH (1,1), the other models successfully
overcome all the diagnostic tests. Without APARCH (1,1), a comparison of all 3 indicators indicates that ARMA
(1,1)-TGARCH (1,1) is the best since it has maximum likelihood and minimum BIC and AIC.

Table 9: Comparisons of models in within-sample estimation performance

Normal Distribution
Models Log-likelihood SBC AIC
ARMA (1,1)-GARCH
4101.584 -7.084090 -7.110389
(1,1)
ARMA (1,1)-APARCH
4107.561 -7.082229 -7.117293
(1,1)
ARMA (1,1)-EGARCH
4106.421 -7.086368 -7.117050
(1,1)
ARMA (1,1)-TGARCH
4107.347 -7.087977 -7.118659
(1,1)
ARMA (1,1)-IGARCH
4092.622 -7.080771 -7.098303
(1,1)
Student’s t distribution
ARMA (1,1)-GARCH
4102.530 -7.079614 -7.110295
(1,1)
ARMA (1,1)-APARCH
4107.990 -7.076855 -7.116303
(1,1)
ARMA (1,1)-EGARCH
4107.027 -7.081301 -7.116366
(1,1)
ARMA (1,1)-TGARCH
4107.768 -7.082589 -7.117653
(1,1)
ARMA (1,1)-IGARCH
4094.235 -7.077451 -7.099367
(1,1)

5.2 Out of sample forecasting performance

The accuracy of a forecasting model is its out-of-sample performance, which measures its performance in “real-
time.” Out-of-sample forecasting is a stepwise method for stimulating real-time performance. To find the out-of-
sample forecasting accuracy of the models, we created a pseudo sample using the period from January 27, 2013,
to December 31, 2016. Then we estimated the variance in stock returns for the period January 01, 2017, to
November 6, 2017. The forecasting performance of the model was compared based on four different indicators
under normal and student t distribution. Root Mean Square Error (RMSE), Mean Absolute Error (MAE), Mean
Absolute Percent Error (MAPE), and Theil inequality (TI).

Table 10: Comparisons of models in out-of-sample forecasting performance

Normal Distribution
Models RMSE MAE MAPE TI
ARMA (1,1)
0.005847 0.004473 133.5426 0.806878
GARCH (1,1)
ARMA (1,1)-
0.005855 0.004495 137.4733 0.804234
APARCH (1,1)
ARMA (1,1)-
0.005871 0.004509 135.5386 0.817928
EGARCH (1,1)

85

Electronic copy available at: https://ssrn.com/abstract=3893019

Asian Institute of Research Economics and Business Quarterly Reviews Vol.4, No.3, 2021

ARMA (1,1)-
0.005855 0.004495 137.5431 0.804392
TGARCH (1,1)
ARMA (1,1)-
0.005847 0.004473 133.5818 0.807652
IGARCH (1,1)
Student’s t Distribution
ARMA (1,1)-
0.005844 0.004474 132.6207 0.802523
GARCH (1,1)
ARMA (1,1)-
0.005855 0.004496 139.4704 0.802119
APARCH (1,1)
ARMA (1,1)-
0.005869 0.004508 137.0148 0.814867
EGARCH (1,1)
ARMA (1,1)-
0.005855 0.004497 139.5167 0.802257
TGARCH (1,1)
ARMA (1,1)-
0.005843 0.004473 133.1608 0.800971
IGARCH (1,1)

Table 10 shows the comparative forecasting accuracy of the different models. For ARMA (1,1)-GARCH (1,1)
model, RMSE, MAPE, and TI decreased while when changing the distributional assumption. Thus, this model’s
forecasting accuracy was improved under the student’s t distribution. Likewise, the forecasting accuracy of ARMA
(1,1)-IGARCH (1,1) was improved under student’s t distribution since all the four indicators decreased. For
ARMA (1,1)-APARCH (1,1) model, MAPE and TI decreased while RMSE remained constant, and MAE
increased under student’s t distribution. Thus, this model’s forecasting accuracy was improved under the student’s
t distribution.

For the ARMA (1,1)-EGARCH (1,1) model, RMSE, MAE, and TI decreased while MAPE increased when
changing distribution assumption. Thus, this model’s forecasting accuracy was improved under the student’s t
distribution. For ARMA (1,1)-TGARCH (1,1) model which had the best in-sample estimation accuracy under
student’s t distribution showed lower accuracy when such distribution was used for out of sample forecasting since
two of the four indicators increased, one (RMSE) constant and another TI decreased. Without ARMA (1,1)-
TGARCH (1,1) model, the rest of the model’s forecasting accuracy was improved under the student’s t distribution
assumption. Considering the student’s t distribution for residuals, a comparison of RMSE, MAE, MAPE, and TI
indicate that ARMA (1,1)-IGARCH (1,1) is the best for out-of-sample forecasting.

6. Conclusion

It is well known that the capital market is the engine of growth for an economy since it contributes to a country’s
economic growth through the creation of wealth. Since the stock market attracts investment, stock return volatility
will have a significant effect on investment and consequently on the whole economy. For this reason, it is very
important to properly model and forecast stock return volatility. In this study, the volatility of the Dhaka Stock
Exchange (DSE) return is tested using the symmetric and asymmetric GARCH models. The Dhaka Stock
Exchange (DSE) is the country’s leading stock exchange. The daily closing prices of DSE for five years are
collected and modelled using five different GARCH models that capture the volatility clustering and leverage
effect for the study period i.e., from 27 January 2013 to 06 November 2017. To estimate volatility models, the
leptokurtic fat-tailed nature of the stock return series usually provides a reason for using skewed distribution such
as student’s t distribution. The main objective was on whether the same result exists in the stock return and whether
the results were improved with student’s t distribution. In particular, the volatility dynamics of the daily stock
return of DSE are modelled using GARCH models such as GARCH, APARCH, EGARCH, TGARCH, and
IGARCH. The findings from the models under the normal distribution assumption for residuals were compared to
the student’s t distribution. All models successfully passed the diagnostic tests under both distribution assumptions
for residuals only except APARCH (1,1) model.

In the sample, estimation accuracy was improved when the student’s t distribution was used. For modelling in-
sample volatility dynamics, ARMA (1,1)-T-GARCH (1,1) was found to be the most accurate model. We further
tried to find the appropriate model for out-of-sample forecasting. In the case of out-of-sample forecasting accuracy,
ARMA (1,1)-I-GARCH (1,1) is considered the best compared to the other three models since MRSE, MAE, and

86

Electronic copy available at: https://ssrn.com/abstract=3893019

Asian Institute of Research Economics and Business Quarterly Reviews Vol.4, No.3, 2021

TI were lower than the other models under student’s t distribution. Since an investor is always interested in making
easy and riskless money, he or she should take into consideration all other factors before investing in the stock
market. Therefore, valuations in such markets should be dealt with carefully by considering conditional variance.
The limitation of the study is that the study used only 5 years’ data of DSE. Future researchers might study to what
extent volatility forecasts based on the present models are useful in the context of structural break, the causes of it
and how it can be considered in the volatility equations.

References

Abd El Aal M. A. (2011). Modelling and forecasting time varying stock return volatility in the Egyptian stock
market. International Research Journal of Finance and Economics, 78, 96-113.
Abdullah, S. M., Siddiqua, S., Siddiquee, M. S. H., & Hossain, N. (2017). Modelling and forecasting exchange
rate volatility in Bangladesh using GARCH models: A comparison based on normal and student’s t-error
distribution. Financial Innovation, 3 (18).
Andersen, T. G., & Bollerslev, T. (1998). Answering the Skeptics: yes, standard volatility models do Provide
accurate forecasts. International Economic Review, 39(4), 885-905
Banumathy, K., & Azhagaiah, R. (2013). Modelling Stock Market Volatility: Evidence from India. Managing
Global Transitions, University of Primorska, Faculty of Management Koper, 13(1), 27-41.
Bollarslev, T. (1986). Generalized autoregressive conditional heteroscedasticity. Journal of Econometrics, 31 (3),
307-327.
Brooks, C. (2002). Introductory Econometrics for Finance. Cambridge University Press.
Dickey, D. A., & Fuller, W. A. (1979). Distribution of the estimators for autoregressive time series with a unit
root. Journal of the American Statistical Association, 74 (366), 427-431.
Ding, Z., Granger, C.W. J., & Engle, R. F. (1993). Long memory properties of stock market returns and a new
model. Journal of Empirical Finance, 1(1), 83-106.
Engle, R.F. (1982). Autoregressive conditional heteroscedasticity with estimates of the variance of UK inflation.
Econometrica. 50(4), 987-1007.
Floros, C. (2008). Modelling Volatility Using GARCH Models: Evidence from Egypt and Israel. Middle Eastern
Finance and Econometrics, 2, 31-41.
Glosten, L. R., Jagannathan, R., & Runkle, D. E. (1993). On the relation between the expected value and the
volatility of the nominal excess return on stocks. The Journal of Finance, 48(5), 1779-1801.
Huq, M. M., Rahman, M. M., Rahman, M. S., Shahin, M. A., & Ali, M. A. (2013). Analysis of volatility and
forecasting general index of Dhaka stock exchange.” American Journal of Economics, 3(5), 229-242.
Karmakar, M. (2005). Modelling conditional volatility of the Indian stock markets. Vikalpa, 30(3): 21-38
Mandelbrot B. (1963). The variation of certain speculative prices. The Journal of Business, 36(4), 394-419.
models and Student-t densities: Evidence from Chittagong Stock Exchange. The International Journal of Business
and Finance Research, 3, 19-34.
Nelson, D. B. (1991). Conditional Heteroscedasticity in Asset Returns: a new approach. Econometrica, 59, 347-
370.
Niyitegeka O., & Tewari, D. D. (2013). Volatility Clustering of the Johannesburg Stock Exchange: Investigation
and analysis. Mediterranean Journal of Social Science, 4(14), 621-626.
Parvaresh M., & Bavaghar M. (2012). Forecasting volatility in Tehran stock market with GARCH models. Journal
of Basic and Applied Scientific Research, 2(1), 150-155
Peters J. (2001). Estimating and forecasting volatility of stock indices using asymmetric GARCH models and
(skewed) student’s t densities.” International Journal of Business Management, 161-176
Qamruzzaman, M. (2015). Estimating and forecasting volatility of stock indices using asymmetric GARCH
models and Student-t densities: Evidence from Chittagong Stock Exchange. International Journal of Business
and Finance Management Resaerch, 2(2), 19-34.
Zakaria S. S. A., & Winker, P. (2012). Modelling Stock Market Volatility using Univariate GARCH Models:
Evidence from Sudan and Egypt. International Journal of Economics and Finance, 4(8), 161-76.
Zakoian, J. (1994). Threshold heteroscedasticity models. Journal of Economic Dynamics and Control, 18(5), 931-
955.

87

Electronic copy available at: https://ssrn.com/abstract=3893019

Asian Institute of Research Economics and Business Quarterly Reviews Vol.4, No.3, 2021

Appendix

Figure 1: Daily closing price of DSE

Figure 2: Return series

88

Electronic copy available at: https://ssrn.com/abstract=3893019

Asian Institute of Research Economics and Business Quarterly Reviews Vol.4, No.3, 2021

Figure 3: Histogram of return series

Figure 4: Volatility of return series

89

Electronic copy available at: https://ssrn.com/abstract=3893019